Exports and fiscal stimulus support growth momentum

Exports and fiscal stimulus support growth momentum

Although down slightly, growth is expected to remain robust in 2018 thanks to exports and budget support. Demand for semiconductors should continue to push exports, benefiting the secondary sector and its industrial conglomerates (chaebols). The Olympic Winter Games in PyeongChang, as well as an agreement on improving diplomatic relations with China, has the potential to increase the number of Chinese tourists (which fell by 45% in 2017 after rising by 36% in 2016) and related revenues. The contribution of exports to growth could nevertheless be lower than in 2017 given escalating trade tensions between the US and China, to which Korea sends a quarter of its exports, 79% of these being intermediate goods.

Stricter regulation on mortgages, put in place to curb housing price speculation, will likely weigh on investment in construction. In addition, despite the opportunities offered by the ICT sector, rising labour costs, stalling productivity gains and higher corporate taxes could lead to a deceleration in private investment. This will be aggravated by a difficult environment, in a context of declining business confidence amid trade war woes. Nonetheless, any negative impact will be cushioned – albeit not entirely – by more expansionary fiscal policy. An increase in public employment, the minimum wage, and social spending is expected to support consumption, although it will remain constrained by the weight of household debt (155% of disposable income).

Inflation is expected to stabilise around the central bank target (2%), driven by higher oil prices and a sharp depreciation of the won. This logic underpins the decision of the central bank, in November 2017, to increase its key interest rate by 25 basis points, the first hike since 2011. The monetary policy stance is expected to remain neutral in 2018, to avoid strangling the consumption of highly indebted households.

Budget surplus persists despite stimulus

The budget surplus is expected to shrink as a result of the expansionary policy. The government's payroll is expected to swell with the hiring of 9,500 additional civil servants. The increase in the private and public minimum wage, various subsidies to reduce inequalities, and financial support to SMEs will also see a rise in spending. The growth of this spending in the social field will be partially offset by a decline in infrastructure spending. In order to respond to the North Korean threat, the defence budget is also rising. The maximum corporate tax rate, up from 22% to 25%, will contribute to higher tax revenues. Public debt, which for Korea is lower than that of its OECD peers, is expected to remain stable and low risk. On the other hand, household debt, which continued to rise in 2017, is a source of concern.

In 2018, the current account surplus is expected to stabilise. The balance of goods is likely to remain in surplus, although export growth will likely be slightly lower than import growth due to higher oil prices and the won’s depreciation. The steadying of relations with China is expected to allow the flow of tourists to stabilise after having plummeted in 2017. The service deficit is not anticipated to widen in 2018 and could even be reduced thanks to the Winter Olympic Games. Foreign exchange reserves will remain at a comfortable level, while the rise in the central bank's key interest rate should help mitigate the risk of depreciation induced by capital outflows in the wake of the tightening of the Fed's monetary policy.

Moon Jae-in paving the way for a peaceful era

Following the dismissal in March 2017 of Park Geun-hye, embroiled in a corruption scandal, Moon Jae-in (Democratic Party) was elected President with an economic programme to stimulate growth, initiate social reform, and reduce the influence of thechaebols. After nearly 10 years of a Conservative presidency, and despite the circumstances of the election, the transition was smooth. His approval rating has been boosted by the success of his dialogue policy with North Korea, as demonstrated by the landslide victory of his party in local elections in June 2018.

Following a tense 2017 with both China and Korea’s northern neighbour, Moon Jae-in successfully organised two historical summits in 2018 with North Korean leader Kim Jung-Un. April 2018 saw took place the first inter-Korean summit in more than a decade. The summit lead to the Panmunjom Declaration, in which both leaders agreed on the denuclearisation of the Korean peninsula, along with greater cooperation between the two countries, setting the ground for peaceful relations. This first meeting set the tone for the long-awaited US-North Korea summit that took place in June in Singapore. It was followed by the return of US soldiers’ remains, a decades-old issue. This decision from Pyongyang, in accordance with the Singapore declaration, allows optimism on the following of the dialogue process, with another inter-Korean summit taking place in September 2018 in Pyongyang. Downside risks to this outlook should however not be dismissed, especially in terms of US-North Korea relations, as demonstrated by the multiple circumvolutions prior to the Singapore summit.